Vendor Financing is a Bad Idea

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There are two theories on how to run exploration companies. First, keep the cash at a bare minimum; only raise what you need and do not run any reserves. Second, over raise by 40% whenever possible; take the dilution and do not run on fumes. If you think the lucky strike is around the corner, the first option is best. However, if you’re smart you run reserves.

A CEO should do two things from a treasury management perspective. One is to control costs, and the second is to keep 20% in reserves at all times. Junior companies should be able to pay bills for the next 12 months while running on fumes. Going into 2009 or 2012 with no reserves could not have been fun.

 

When a company under raises, it always ends up doing desperation financings later and wiping out existing shareholders at some point. If a junior company owes a drilling company $300,000, it will likely pay the bill with nickel paper. If the company had financed on the way in, it would likely have paid with two-bit paper or even $1 paper.

Vendor financing is easy to pontificate about from on high, but the reality is everyone gets desperate for cash. However, next time you’re offered money on reasonable terms, take it. It is painful when companies that should be trading at $1 per share do $0.05 or $0.20 financings.

From a personal perspective, I have never been able to operate with optimal reserves because budgets have always been expanded in a crisis to match cash on hand. However, since I have started focusing on reserves as the ideal way to run companies, I have maintained three to six months cash reserves on almost every project I have headed. My goal is to get to one year’s worth of cash reserves.

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